Loan shuffle

Better to pay mortgage on rental property or switch it to personal residence?

By

LewSichelman

WASHINGTON (MarketWatch) - Question: I have two small rental houses and a personal residence. I bought the rentals cheap, and thanks largely to sweat equity, both have more or less doubled in value.

I had a 8.75% mortgage with a balance of $45,000 on one rental, and a 7.85% loan on the other with a balance of $68,000. Given the relatively high interest rates, I decided to refinance Rental A at about 6%, and use the equity from that property to pay off the loan on Rental B. Effectively, I refinanced both in one deal.

A month after closing, I received my new payment book and other papers and discovered that instead of paying off the loan on Rental B, the boobs paid off the loan on my personal home, which had roughly the same balance. When I informed the closing company of the mistake, nothing was really said or done, and after several attempts to fix things, I got tired of unreturned calls and gave up. Besides, I thought, "Cool. I have all my risk in Rental A and two houses paid off."

The only rub is I am still paying an interest rate of 7.85%, when the rate on my house loan was around 6.25%. I plan to own rental houses forever as my "401(k)" plan, and expect to buy more. I will likely sell my home sometime in the next 10 years, once I have a family, so I will be in a better school district. Am I missing any savings by having it structured like it is? Chad Mankins, Denton, Texas.

Answer: You need to sit down with a financial adviser or tax expert and go over this with him or her. That person should be able to tell you which is better, paying interest on a mortgage for your personal house or on a loan on a rental house. Interest in both situations is tax deductible, so I don't see what the difference would be by keeping the loan on your rental property or moving it back to your personal residence.

If you decide to refinance your residence in order to pay off the loan on Rental A, realize that you will incur another round of expensive closing costs that, for the most part, cannot be written off like they would (as a business expense) if you were refinancing a rental property. Also, if you still chose to go this route, I probably don't have to tell you this, but I will anyway: Use another closing agent!

Question: My daughter's family was living in a small condo when she had a second child. A larger house became necessary. At the time, (two years ago) a house across the street from me became available. My wife and I have lived in our home for the last 36 years (mortgage free) and my daughter and her husband loved the idea of living so close. My wife and I bought the home across the street with the expectation that my daughter would purchase it from us upon the sale of their condo. Unfortunately, that was the beginning of the housing crunch in Southern California and the condo did not sell.

Since then, we have been paying the mortgage on the new home across the street and my daughter has been paying the mortgage on a vacant condo. Now, my son is in the process of assuming the loan on the condo for himself. After that is complete, my daughter and son-in-law will purchase the home from us. Since the rules for financing have tightened, we are worried that they might not qualify for a mortgage for the amount of the new home. Do you think seller financing would be the way to go for us? What advice would you give me or what avenues for research can I explore? We want my daughter to get the benefit of the tax deductions for the mortgage and taxes instead of us, as has been the case for the past two years. I know practically nothing about real estate and financing. Samuel Kibler.

Answer: First off, you daughter and son-in-law should apply for a mortgage and see if they qualify. As long as they have good credit, good incomes and have been steadily working in their respective fields, they should be approved. Despite what you may have read or heard, funding is still plentiful for folks who meet those major criteria. It's the would-be borrowers with credit dings that are having trouble lining up financing.

If they qualify, let them go that route. Believe me, no matter how good a relationship you have with them, the last thing you want to do is become their lender. The only thing that destroys more close-knit families than inter-family financial transactions is alcohol and drugs.

If they fail to qualify for the amount they need, than you should consider giving them a gift of the cash they need to make up the difference between what they can borrow and the value of the property. Both you and your wife can make tax-deductible cash gifts to your children each year. And assuming you plan to leave everything to them anyway, it might be better to give some of your estate away now when they need the help the most.

If that doesn't work, you could lend them the difference as a second mortgage. Or, you could lend them the whole amount. Before deciding, though, you should consult your financial adviser so that you can make the best choice for your own situation, not the kids.

If you chose to become their lender, please, please, please make it an arm's length transaction at the going interest rate. Otherwise, Uncle Sam may look askance at the deal. And look for a company which can do all the paperwork for you, collect the payments and pay the taxes and insurance. That's the right way to lend family members money. One such company with which I am familiar is Circle Lending, which was recently bought by Virgin USA, Richard Branson's North American Investment Group, and is now called Virgin Money. LendingClub.com is another.

Feedback

Reader Ron MacQuarrie rightfully points out that in cases where escrow companies make mistakes on the closing statements, borrowers usually sign a paper at closing that says they promise to work with the company and the lender as necessary to correct the problem. See previous Realty Q&A.

So in this case - and most others like it - the borrower agrees in advance to make up the difference in any miscalculation that was made in the borrower's favor. "This was instituted mainly because of egregious errors from escrow companies like this one," MacQuarrie writes. "I've seen this many times before."

He says situations like this should be reported to your state real estate commission, which has jurisdiction over such matters. "Without complaints," MacQuarrie advises, "regulators wouldn't know to keep an eye on that company, and if they continue to screw up like that, shut them down."

Intraday Data provided by SIX Financial Information and subject to terms of use. Historical and current end-of-day data provided by SIX Financial Information. All quotes are in local exchange time. Real-time last sale data for U.S. stock quotes reflect trades reported through Nasdaq only. Intraday data delayed at least 15 minutes or per exchange requirements.